A New Landscape of TDFs in Retirement Plans

Last
year was a busy year for target-date fund (TDF) decisions and changes within
defined contribution (DC) plans, a survey finds.

According
to the 2015 Defined Contribution (DC) Trends Survey by the Callan Investments
Institute, about one in 10 plan sponsors replaced their target-date
fund/balanced fund manager in 2014, and the proportion of plans that offer
their recordkeeper’s proprietary TDF declined precipitously, from 47.5% in 2013, to 28.7% in 2014. Plan sponsors expect this number will decrease even further
in 2015 (to 23.6%).

Lori
Lucas, executive vice president and Defined Contribution Practice leader at
Callan Associates in Chicago, said the change in the TDF landscape was what
stood out to her in the survey findings. “I was not surprised by the change
away from recordkeeper’s proprietary funds, but was surprised by how many DC
plans are using custom target-date funds,” she tells PLANADVISER.

According
to the survey, plans with custom target-date funds increased materially, from
11.5% in 2013 to 22.3% in 2014. Lucas says Callan did expect an increase in
plans using custom TDFs, but were surprised by the size of the increase.

The survey also found
the proportion of plans with indexed TDFs remained steady between 2013 and 2014
at around 42%, and TDFs continue to trump other options as the most prevalent
choice of default investment fund for participant-directed monies (74.6%). This
year, fees now outrank performance as a criterion for selecting or retaining a
TDF. Fees had ranked third between 2009 and 2013, but are now in second place, behind portfolio construction.

Lucas
says she found it interesting that although 12% of plan sponsors said they had
replaced their TDF managers, none said they expected to do so in 2015. “It seems
to me like the Department of Labor’s [DOL] tips for TDFs raises the bar; it sets up the expectation by the DOL that a plan’s TDF will
fit the demographics of participants and the plan, and that plan sponsors would
have documented this,” she says. Lucas
also notes that TDFs have evolved considerably over the years—glide paths have
evolved, some are more aggressive now after becoming more conservative after the
recession. “These are all merits for reevaluating TDFs and having a documented
process.” Lucas adds that plan advisers can prompt plan sponsors to benchmark
their TDFs and guide them in the process.

Lucas
says there were a couple of disappointing findings in the survey. Callan
expected to see more of a shift in the DC plan fee landscape. “Last year, we
saw a lot of activity in fee analysis and recordkeeper searches,” she says. “We
thought more [plan sponsors] were moving to out-of-pocket fees—those taken
directly out of participants’ accounts—and moving away from revenue sharing, but
the survey results didn’t show this,” she notes. The survey shows plan sponsors
are changing the way fees are paid, but it is not clear from the findings how
they are doing this.

The
survey found fewer plan sponsors calculated or benchmarked plan fees in 2014
than in 2013, and fewer reduced plan fees after conducting a fee evaluation.
More than twice
as many plan sponsors changed the way fees are paid in 2014 as in 2013. More
plan sponsors did not know what portion of their funds pay revenue sharing this
year versus last (8.3% in 2014 versus 2.6% in 2013). More plan sponsors also
changed the way fees are communicated to participants.

More
than half of plan sponsors are somewhat or very likely to conduct a fee study
in 2015. Furthermore, 46.7% of plan sponsors are somewhat or very likely to
switch certain funds to lower-fee share classes and 44.3% intend to renegotiate
recordkeeper fees in the coming year.

Lucas says there is still
work for plan sponsors to do related to fees. Asked if there was a policy for
fees, just 21% of plan sponsors surveyed indicated they do have a written fee
policy as part of an investment policy statement (IPS), and 15% have one in a separate document. Only 5% plan to
formalize a fee policy in 2015. “It is a good idea for investment committees to
document a fee policy and the way fees are paid. The bar is high given all the transparency
requirements and lawsuits,” she says. Advisers can help plan sponsors with a
fee policy.

Other
“good news/not so good news” findings, according to Lucas, relate to automatic
enrollment. Automatic enrollment usage increased for the fourth year in a row
to reach 61.7% of plans. But, Lucas notes, implementation of auto enrollment is
not necessarily ideal. Plan sponsors continue to offer automatic enrollment
primarily to new hires, with only 12.5% also including existing employees.
Lucas says the main reason plan sponsors cited for not implementing auto
enrollment for all employees was cost. “It is such an effective tool for
getting people into the plan, that when a plan sponsor offers a matching
contribution, it increases their plan costs. So, to make it more affordable,
they just focus on new hires,” she explains.

A
second reason plan sponsors give for offering auto enrollment only to new hires
is the expected pushback from current employees. Lucas says they overestimate
the amount of pushback they’ll receive. “They think employees that have been
receiving a paycheck for a while will react negatively to a decrease in that
paycheck, but our experience indicates this is not true.”

Another
issue with auto enrollment implementation revealed by the survey: only
one-third of plans offer both automatic enrollment and automatic contribution
escalation. In addition, defaults for automatic enrollment range from 1% to
10%, with an average of 4.3%, and plans with opt-out automatic contribution
escalation most frequently have an annual increase rate of 1% with a cap of 6%.
Lucas notes that a default 3% deferral is still the most common among plans, and
escalating by 1% each year up to 6% is not the best formula for retirement
readiness. “Most in the industry recommend saving 10% to 15% of pay; we didn’t
see much movement towards that,” she says.

One
thing Lucas thinks plan sponsors should think about is what response they will
have to new money market regulations. Few plan sponsors are making changes to
their investment fund lineup despite the Securities and Exchange Commission’s recent amendments to money market regulations. “We received kind of a muted response from plan
sponsors, but it may be an area where they’re taking a wait-and-see approach,” she
says. Forty-three percent of respondents indicated they are still evaluating
what the new regulations mean for them. “The regulations not only affect money
market funds but funds that use money market funds as underlying investments,” Lucas
notes.

Many
plan sponsors increased the proportion of index funds in the plan (27.3%). This
trend should continue in 2015;

More
than three-quarters of plans (77.3%) now offer some kind of institutional
structure—either collective trusts, separate accounts, or unitized private
label funds;

Most
DC plan sponsors do not offer a retirement income solution and are unlikely to
do so in 2015. When they do offer one, it tends to be via access to their
defined benefit plan;

Many
plan sponsors provide a retirement income projection to participants, and
communicating about retirement income adequacy is a high priority. However, few
sponsors use retirement income adequacy to measure the success of their plan;
and

In 2015, participant
communication, fund/manager due diligence, compliance, and plan fees are high
priorities.